Will economy buckle under crude oil shock in 2018?

 NEW DELHI: After three years in the goldilocks zone, India’s economy is back to confronting its biggest bogeyman: rude crude. Brent crude prices are now teasing the $70 per barrel mark — even breaching the line a little while on Thursday.

Over the last half year, Brent crude rates have risen by 55.78 per cent — between June 22 ($44.82) and January 12 ($69.82) —  and bullish price trends are being fuelled by several factors. Geopolitics is one, according to former ambassador to Syria and Turkey Rajendra Abhyankar. Internal power shifts in Saudi Arabia and recent pro-Saudi US moves have upset the power balance, making markets jittery. More recently, the increased cohesiveness of the OPEC cartel and consequent commitments to production cuts; coupled with increased winter demand has sustained the rally.

But, even pessimistic forecasts see this as transitory, not lasting more than a year. “We should not get carried away that $70 will be the new normal..,” Madan Sabnavis, chief economist, CARE Ratings said. On the downside, CARE believes that the rally will continue “till March for certain” when winter demand will ease and the US shale industry’s production plans become clear.  “The only relief in the foreseeable future could be if US production picks up even more,” it noted.

Even a short term rally is unlikely to be pleasant for an oil-guzzler like India. India is the world’s third largest oil consumer, importing around 4.2 million barrels a day and upwards of 80 per cent of its oil needs.

When Prime Minister Narendra Modi came to power in May 2014, crude prices were around $110 a barrel. In less than a year, that had fallen to $50 (January 28, 2015) and has since stayed largely within the $45-$60 range.

Gains from this fall were huge: reducing the import bill, strengthening the rupee and giving space for public expenditure. While a third of the benefit was passed along to consumers, the government channeled a large portion via hiked excise duties into public investment and reducing the fiscal deficit. “... the benefit was between 1 to 1.5 per cent of GDP growth,” says economist Ajit Ranade. But now, that position is being threatened.

“Firstly, the fiscal space will shrink, and oil subsidy burden will increase (even with substantial deregulation). Secondly, there will be an inflationary impact, possibly by as much as 0.5 per cent. Thirdly, the current account deficit will expand, causing the rupee to weaken... And, with higher inflation, the scope for cuts in rates is gone.” Sabnavis believes a dollar increase in prices on a permanent basis would increase the import bill “by roughly Rs 10,000 crore on an annual basis”.

The government may be more worried about inflation. Estimates say retail inflation as measured by the CPI could see a 0.35 per cent rise for every 10 per cent increase in crude rates.

With this year scheduled to see several politically significant state elections and the Lok Sabha polls just around the corner in 2019, the government is unlikely to let retail consumers take the brunt of sharp broad-based inflation. Letting inflation accelerate will also clamp down on rate cuts by the RBI, says Jaijit Bhattacharya, head- economic, regulatory and policy advisory at KPMG. If the number crosses six per cent, the RBI might begin hiking rates, Sabnavis adds.

A higher rate regime would directly impact industrial credit offtake, further strangle private investment and impact growth. “The recovery process will be affected... the impact will start with a weak currency, leading to RBI interventions, higher interest rates and slowed investment,” he observes.

However, options to mitigate the fallout are limited. “There is an important call the government will have to take: either subsidise the rise or reduce taxes,” observes Sabnavis. Both these options are fraught with peril. With post-GST tax revenue collections lower than expected, both options cut down room for expenditure while the former also goes against the ongoing mission to reduce the subsidy burden.

“Possibly, it will be a mix of duty cuts and subsidies,” Bhattacharya said. Which way the government decides to go will become clearer with the presentation of the Union Budget on February 1, when Finance Minister Arun Jaitley will walk a tightrope between economic and political necessities.